Energy’s New Risk-Reward Equation

For Americans who recall the 1973 Mideast oil embargo, last fall’s forecast about future U.S. petroleum output was a revelation. Craig Fundum, president of Zurich Commercial Markets, called the prediction that America was “on pace to out-produce Saudi Arabia in oil and gas by 2020″ a “turnaround few people would expect.”

Fundum was quoting from the 2012 World Energy Outlook, prepared by the Paris-based International Energy Agency. The IEA’s findings were confirmed by Zurich’s own studies of the U.S. economy and emerging areas of stepped-up activity. Analyzing its proprietary research, Zurich saw expanding opportunities in U.S. oil and gas.

The point of these studies was to estimate what these newly dynamic growth sectors will mean for employment, investment and overall commercial risk. The report also sketched scenarios related to sustainability—environmental as well as financial. Enterprise risk management (ERM) is the instrument that’s typically deployed by Zurich Commercial Markets in such cases. ERM uses business risk as a lens and a tool for long-range strategic planning, to connect the dots between diverse operating conditions and future outcomes.

The premise is that companies can’t adapt properly to changing conditions without accurate, detailed data and a forward-looking analysis. When industries swap their doldrums for rapid expansion, they are naturally prone to growing pains and unintended consequences. That observation similarly applies to natural gas and petroleum production in the Midwest and Plains states, where the technology of hydraulic fracturing has opened new possibilities. Zurich, with a sizable customer base long established in this region, quickly set to work creating risk models in response to the fracking groundswell.

“Among our many insured in the petroleum boom areas, we had a lot of trucking firms and oil jobbers,” says Fundum. “Their concern was making pickups and deliveries in a very tight timeframe and avoiding business interruption. We were aware that they might not be studying the size and load capacity of all the roads they would end up using.” Zurich specialists began an in-depth mapping and analysis project to assess transport infrastructure in the new oil and gas patch.

The technology to support projects of this type is highly advanced, according to Fundum. “We started looking at GPS data and also at the vehicle telematics,” he says. “From a dispatch or monitoring location you can see vehicle speeds, hard braking, engine temps and other characteristics. We’re able to create models from that data plus infrastructure data, and provide guidance that reduces risk and optimizes performance.”

Energy production in the central U.S. has already lifted regional economies and created sizable wealth. Its risk/opportunity profile is intriguing for many reasons, including notable variety on the risk side. Producing and selling petroleum products always courts market risks related to unit price and marginal demand. Global markets for oil and natural gas are highly liquid and well-hedged, but many “haircut” losses together can equal at least a minor catastrophe. It’s worth noting recent news reports about the declining state of the ethanol market, which is partly a case of unexpected dips in U.S. demand for fuel.

In addition, the fracking technique gives rise to reputational risk issues, principally related to environmental damage or degradation. In the short span of time since hydraulic fracturing came into wide use, it has already been the subject of a high-profile Hollywood movie cast as a cautionary tale.

Between now and 2020, the story of resurgent domestic energy production will likely be an inspiring one. Its spotlight naturally shines on technical innovation and a motivation to create new, high-value solutions. Fundum feels that he and his colleagues are embedded in that process—through consulting and forecasting, but also by their underwriting function. “Businesses can’t operate without loss protection,” he states simply. “The drive for innovation we continue to see wouldn’t happen without insurance. When you provide what we provide, at the highest level of service, there is huge economic value to that.”